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Abstract

This study proposes an original formal political economy model of institutional
evolution to analyze the effects of evolving interest groups on institutional change by
extending the model of Neyaptı (2010). Institutions are categorized as formal (F) and
informal (N) institutions that exhibit different evolutionary patterns. N evolves with
capital accumulation, as in learning by doing, and F is optimally chosen by a
government who maximizes the weighted sum of the utilities of two different interest
groups. The level of informal institutions, which represents business ethics, way of
doing business or the level of technological know-how, differs for each group. F and
N together define the production technology and affect the income level of each
group. The model is such that institutions, as well as the levels of income and capital
stocks are dynamically interrelated. The simulations of the model show that F
exhibits a punctuated evolutionary path. This path is observed to be affected by
income share of the institutions, income share of the capital, saving rate and cost of
institutional change.